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:: COMMERCIAL FINANCE :: |
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FAQ’s
What is a commercial mortgage?
How does it work?
Advantages and Disadvantages
Buying vs Renting
What is the usual length of a mortgage?
How much cash do a I need to provide for a down payment?
How should the mortgage be structured?
How can I improve my chances of getting a mortgage?
Who is responsible for the repayment of the mortgage?
Where can I get further help?
What is a commercial mortgage?
A commercial mortgage is often the best way to finance the purchase of
land and/or buildings for a business. It probably provides the most flexible and affordable financing
solution
A commercial mortgage is a specialised commercial loan in which the lender has a
legal claim over the property until the loan has fully been repaid. When arranging a mortgage, consider its
effects on your cash flow and assets. This guide will give you a general overview. It does not replace professional advice. You may wish to consult your accountant and tax advisor before finalising a loan to reap the maximum benefit and avoid complications.
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How does it work?
Mortgages may be structured several different ways but the two most important aspects to consider are the interest rate (type) and the repayment schedule for the mortgage.
There are two interest rate options to consider
- Fixed Rate: With a fixed rate the interest rate (i.e. the percentage) applied to the outstanding principal remains constant through out a pre-determined period that may or may not equal the length of your mortgage. The interest rate is set at the beginning of the mortgage by examining the risk involved and the current market rates. The advantage of a fixed rate loan is that the interest rate is fixed and will not rise if the market rate rises. The disadvantage is that the borrower will not benefit from any reduction of the market rate.
- Variable Interest Rate: With a variable interest rate the interest rate applied on the outstanding principal fluctuates from in line with changes to the Bank Base Rate or LIBOR and, as a result, so will the amount of payments. The interest rate for each period will be the current market rate plus a pre-determined premium that remains constant throughout the life of the mortgage. Generally, you can initially get a lower interest rate on variable interest rate than on a fixed rate mortgage. The advantage of an adjustable interest rate mortgage is that you save money when the market rate decreases. The disadvantage is that you are not protected from an increase in the market rate and the interest rate you pay will increase with the market rate.
When deciding on your repayment schedule you should always remember the longer you
take to payback the principal the higher your total interest payment will be.
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Advantages & Disadvantages
| Advantages |
Disadvantages |
- Retain Ownership. Instead of raising funds by selling an interest in the property or the business to an investor, you retain complete ownership of both. The lender is only entitled to an interest return on its mortgage, not a percentage of ownership that an investor would expect. Also he/she can only exercise the right if you default. You retain all the benefits of ownership in an asset that has the potential to appreciate in value.
- Better Cash Flow. A mortgage gives you access to capital with minimal up-front payments and the flexibility to design a repayment schedule that suits your needs.
- Maximize Financial Leverage. Financing your property purchase with a mortgage will allow you to use your cash flow for other pressing needs.
- Tax advantage. Interest payments on your mortgage are tax deductible and are made with pre-tax money. Purchases financed with profits, in contrast, are, made with after-tax money.
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- Collateral. The nature of a mortgage requires you to pledge the purchased property to the lender. If you default on the mortgage, the lender is able to foreclose upon the property and sell it to repay the money owed to the lender. Make sure that when the mortgage is repaid, the lender is obligated to release its mortgage and is required to file the requisite documents acknowledging this release.
- Defaults. The lender may define a variety of events that will constitute a default on the mortgage, including failure to make any payment on time, bankruptcy, insolvency and breaches of any obligations in the mortgage documents. Try to negotiate advance written notice of any alleged default, with a reasonable amount of time to cure the default.
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Buying vs Renting
Purchasing property is a large decision for any business.
| Advantages |
Disadvantages |
- Fixing your overhead costs. When you finance your purchase with a mortgage you have a repayment schedule that sets your fixed expense each month.
- Potential asset appreciation.
- Potential to sublet. If you purchase more space than your company currently needs, you could sublet a portion of it until you need the space.
- Mortgage payments may be cheaper then rent. When you set your repayment schedule you know what your payments will be in advance. When you rent your property, you are exposed to market conditions that may increase your rent to above what your mortgage payments would have been.
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- Harder to relocate. If you have a lease and decide to change locations the process is relatively simple. When you own the property, you need to determine if you should sell the land or find a new tenant.
- Drain on cash. A mortgage will not provide 100% of the financing needed to acquire the property. You will need to use your current cash to finance a down payment and pay for any related expenses.
- More management responsibilities. When you let the property, the landlord is responsible for the upkeep and security of the property.
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What is the usual length of a mortgage?
Mortgages are typically available for any time period between 5 to 25 years. For commercial mortgages the maximum length of the mortgage is usually 20 years for newer properties and 15 years for older
properties.
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How much cash do I need to provide for a down payment?
Typically lenders often view mortgages with larger down payments as more secure. Most lenders typically like to receive 20% to 30% of the purchase price as a down payment. Depending on your company's financial history, as little as 5% of the purchase price may be required for a down payment. (You will most likely have to pay a higher interest rate to compensate for the smaller down payment). You should remember, that the larger
your down payment is, the less you have to borrow.
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How should the mortgage be structured?
If possible, you should form a separate business entity to lease the building to
your operating company. This separate entity should then arrange for a non-recourse mortgage for the purchase of the property. This should protect your operating business if you default on the mortgage. You may wish to consult your accountant or tax advisor.
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How can I improve my chances of getting a mortgage?
Be prepared to demonstrate why you have a solid chance of repaying the mortgage. The lien on your property adds security but the lender will still base their decision on your ability to repay the mortgage. It will be extremely
beneficial to be able to show the lender a history of your earnings and a projection of future earnings. Also
expect the lender to arrange for a property appraiser to estimate the market value of the property; this will help the lender feel that the property is sufficient collateral for the mortgage.
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Who is responsible for the repayment of the mortgage?
The legal structure of your company will determine who is responsible for the repayment of the mortgage and who will be liable if it is not repaid. If you are a sole trader, you bear all the responsibility and potential liability. If your have formed a partnership, all of the partners involved are jointly and individually responsible. If you are a legal company, where the Directors have provided personal guarantees to the bank, they may be personally liable if the mortgage is not repaid.
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Where can I get further help?
We have over 100 lenders on our panel covering the whole spectrum of finance for all types of business.
Call or email us for an immediate decision in principle (“DIP”) or complete and fax the Dip form.
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